Charlie Brown, Lucy, and OPEC

The reaction of oil markets, the trade press, and some analysts to last week’s OPEC agreement is reminiscent of the Charlie Brown and Lucy. Lucy keeps telling Charlie that she won’t pull the football away when he goes to kick it but does repeatedly. And. good old Charlie keeps trusting, when he at a minimum should be skeptical just as the trade press and others should be..

After OPEC agreed to reduce production by 1.2 million barrels per day, prices rose by 10% and the trade press and some analysts wrote that OPEC was reasserting its control and that reports of its demise were premature. Oil analysts and historian, Daniel Yergin said, “The member countries were faced with a “very deep” abyss of low oil prices, and that won out over politics. …OPEC is back in business … This will rank as one of their historic decisions.”

Well, maybe. History, however, is not reassuring. Since the first oil embargo in 1973, OPEC has mainly been a price taker; not a price maker. Agreements to cap or reduce production have failed because OPEC lacks an enforcement mechanism and members have a strong incentive to cheat. That is likely to be the case with this agreement. Saudi Arabia and Iran came to an agreement, which had eluded them in the past, that allows Iran to increase production by 909,000 barrels a day as it tries to rebuild its economy after the end of Western Sanctions. Why should Iran stop at 90,000 barrels once its oil infrastructure is rebuilt? Why should Venezuela, an economic basket case, or Iraq honor the agreement’s limits? Russia, which produces about 10.32 million barrels a day has agreed to cut production 300,000 barrels. But, Russia’s economy and adventurism needs more hard currency, so if prices rise it too will have an incentive to cheat.

If prices rise above $50 a barrel, OPEC members will see their revenue increase, which is their goal, but that increase will create an incentive to try for more. Hence, more cheating.

As prices go up, more US production, especially shale, will come back on line and that will have the effect of offsetting OPEC production cuts. In 1973, OPEC produced 54% of the world’s production. Today, it is down to 42% and only Saudi Arabia and Iraq are among the top five global producers, according to Statista. If most OPEC members, especially Saudi Arabia honor this agreement, US oil producers will owe them a big thank you.